Social Investing via DeFi+Creators
A group of Reddit traders almost bankrupted a multi-billion dollar hedge fund.
This is a hilarious story, but it also showcases a real problem.
Retail investors are tired of being on the losing side of the market. Wall Street is notorious for manipulating markets or having access to special trades that small-time retail investors don’t. In fact, most Wall Street funds won’t even let common people invest in their funds as they require individuals to have huge net worths and large amounts of capital available.
So, the retail investor is left with Robinhood and the Motley Fool to make their trades.
But the GameStop rally showed something: acting in unison, millions of retail traders have the same trading power that a hedge fund does. In other words, there can be a hedge fund of retail investors. Such an event is rare though, because even on WallStreet Bets, getting the necessary traction is difficult and there is a lack of organization.
However, decentralized finance, aka DeFi, can mitigate this issue and create a retail hedge fund via social investing.
DeFi
Buzzword alert: Blockchain. In all honesty, I didn’t believe in blockchain’s long term viability until about a year ago. Yet, an investment app based on blockchain is the answer.
I believe that such an app would have to be decentralized in nature to succeed. DeFi would allow retail investors to use blockchain to execute their trades and manage funds. One of the major problems is the clearing time and fund settlement period. Traditional banking intermediaries including Robinhood can take up to 5 days to settle funds. This is a primary disadvantage that retailers face as they can often not access their own funds instantaneously.
DeFi would fix this because cryptocurrency transfers happen instantaneously hence a DeFi system would allow for expanded access to capital.
The other primary advantage of DeFi is the anonymity it can provide through smart contracts, a huge advantage that can allow retailers to have the same privacy hedge funds do.
Social Investing
Recently, we’ve seen a new trend emerge: social investing. Retail investors prefer to move in a collective rather than operate individually.
WallStreet Bets is a prime example as it has roughly 9 million subscribers now. Traditionally, the flow of information is very limited in Wall Street. Institutional investors have access to top research, alternative data, and inside “tips” but this information never flows to retailers for the most part. However, public forums like WallStreet Bets allow people to aggregate their knowledge and form a collective investment thesis based on research from millions of people.
This collective power of analysis is what allowed the GameStop short squeeze opportunity to be identified.
We’ve also seen apps like Public gain traction. Platforms such as Public combine social networks and investing. Public allows people to see how their friends and others invest. However, this leaves a major problem, what if your friends don’t know much about investing? In fact, why should I invest with anyone other than an experienced investor?
But, how?
Enter Discord. As retail investors trade more, we’ve seen dozens if not hundreds of Discord communities emerge where self-proclaimed stock gurus send out trade signals in exchange for a hefty subscription ($50 per month is common). Hundreds of thousands retail investors are paying for such groups yet there’s many problems.
- What are the actual qualifications of these gurus? How often are they actually correct?
- Why can’t I automatically mirror their trades instead of having to constantly be active on Discord to wait for an alert? It is important to be always active as these trades may only be “alive” for a few minutes and arrive spontaneously.
- Why is the payment model not based on the group leader’s performance? After all, why should one pay if they lose money?
Hence, this presents a massive opportunity.
The Framework
I envision a trading platform that is based on DeFi. All transactions would be conducted via stablecoin and blockchain to allow for instantaneous access to capital.
Retail investors could view trade ideas and vote on them. The system would highlight popular trades, similar to how the Tik Tok algorithm promotes content that has high user engagement. These ideas don’t have to be limited to blog posts or tweet-sized blocks, I imagine they could even work like Tik Tok style videos where investors watch and then swipe right or left (yes, like Tinder) depending on if you like the pitch. There would be a page for each trade where there would be more insight available such as a detailed write-up or additional perspectives.
At some threshold, such as if the idea has received enough upvotes or likes, investors could be given the option to enter into this trade. However, the trade would only be executed if there is enough traction to execute it. For example, if 1 million people commit to buying GameStop then the trade will execute.
To prevent manipulation by quantitative trading funds, the threshold would be kept hidden. But, how would we account for people not following up on trades?
This would be enforced via smart contracts. Smart contracts are digital contracts that automatically execute once certain conditions are met. In this case, the condition would be if the threshold is passed and the contact itself would be the commitment of capital from a retail investor.
The purpose behind using smart contracts and making the threshold hidden would be to provide this large retail trade the same level of privacy that hedge funds have. This would prevent traditional Wall Street manipulation and could effectively allow retail investors to operate with the sophistication of a hedge fund.
There could also be built in tools in this app such as automatically adding a hedge, making a portion of the investment leveraged via options, having a staggered sell approach, etc.
Investors as Creators (IaC’s)
I previously mentioned crowdsourcing trade ideas and presenting them via Tik Tok style videos. This would essentially allow experienced investors to become creators or IaC’s.
In traditional investing terms, they would be considered analysts or fund managers, but in modern reality they would be investment influencers. Currently, these IaC’s are on platforms like Youtube where they have niche followings. These influencers create videos on a stock to pitch them and then are done. Some influencers choose to create a Discord community but those have their own problems as we mentioned.
This hypothetical platform would allow these IaC’s to monetize their brand far beyond creating a Patreon or selling merchandise. Creators could charge subscription fees for premium trade ideas, create funds which they actively/passively manage, and earn commissions of trade ideas of theirs which were executed.
After a short trial, the platform would automatically filter out the “best” investment creators. The term “best” is difficult to define in this case because it will vary based upon people’s risk appetite and expectations for returns.
Nonetheless, these IaC’s could earn by actively managing others’ money. Traditionally, regulatory oversight prevents people from managing outside capital due to required licenses. However, automatically mirrored trades would create an alternative to this which would allow people to circumvent complex bureaucratic red tape. Technically, you aren’t managing money, other investors are just mirroring your trades.
Conclusion
I believe when such a company emerges, it will go beyond “democratizing investing.” Rather, it will level the playing field and allow retail investors to have the same opportunities that a high net worth individual or hedge fund has access to with the same degree of sophistication.
This platform would be a true home for IaC’s and provide retailers with an alternative to day trading or putting money into an ETF.
DeFi is the future of investing and will give true power back to the individual investor.
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